Drugstore Margins Remain Stable in Latest Gov’t Data

The U.S. Census Bureau just released its 2010 Annual Retail Trade Report. These government-collected data provide the most complete picture of revenues at all store-based retail drugstores, not just the larger public companies.

Contrary to what you may have heard, the financial position of retail drugstores has not deteriorated in recent years. Here are some surprising facts from the government’s latest official data:

• In 2010, total gross profits of drugstores and pharmacies were $53.3 billion, up $1.8 billion (+3.5%) vs. 2009. Gross profits have increased every year since 2000.
• Gross margins (gross profits as a % of sales) averaged about 26% from 1993 through 2006, and averaged about 24% from 2007 through 2010. Gross margins were stable from 2007 to 2010.

Below, I speculate on what happened in 2006 that changed the trend. Feel free to add your own guesses in the comments.

THE DATA

NAICS (North American Industry Classification System) is the standard used by federal agencies in classifying business establishments for the purpose of collecting, analyzing, and publishing statistical data related to the U.S. business economy. Pharmacies and drugstores are classified in NAICS 446110. NAICS replaced the Standard Industrial Classification (SIC) system in 1997.

Click here to download the gross margin data as an Excel spreadsheet from the Census site. Pharmacies and Drug Stores are on row 20.

A few comments:

• These figures do not show prescription gross margins. The drugstore data include retail revenues and gross profits from both prescription and non-prescription products. Chain drugstores such as CVS' retail business (NYSE: CVS) and Walgreens (NYSE: WAG) generate about one-third of their revenues from non-prescription, front-end items. Independent drugstores, meanwhile, generate less than 10% of their revenues from non-prescription sales. Public companies also have other sources of revenues and profits.
• NAICS 446110 excludes non-pharmacy retail formats (supermarkets and mass merchants) and mail-order pharmacies.
• The Census Bureau defines gross profit to be "Sales minus Purchases," i.e., cost of goods. This definition may not correspond precisely to definitions used in public company accounting reports, although I believe it's close.

STEADY AS SHE GOES

You may be surprised to learn that drugstore margins are not collapsing. In fact, overall profit margins are pretty stable.

The U.S. Census Bureau’s latest retail data show 2010 gross margins for Pharmacies and Drug Stores (NAICS 44611) to have been 23.9%—identical to the 2007 gross margin figure. These data are consistent with NCPA member surveys showing that overall gross profit margins for independent drugstores have remained stable—ranging from 22% to 24% over the past 10 years.

Total gross profit dollars actually increased during this period along with total drugstores revenues. In 2010, total drugstore gross profits were $53.3 billion in 2010, up $1.8 billion (+3.5%) vs. 2009. (See chart below.) For comparison, NACDS reported that prescriptions at chain and independent drugstores grew by only 1.1%. (source)

There is one notable restatement in this year's data. Last year, the Census Bureau reported an unusual jump in pharmacy margins for 2009. (See Drugstore Margins Jump in New Gov’t Data.). The restated data are more consistent with historical data releases. Sorry, I have no idea what happened in the 2009 annual report.

WHAT HAPPENED AFTER 2006?

The chart above shows a margin decline starting 2006. Here are three possible explanations:

• Walmart launched its discount generic program, which was subsequently matched by many retail drugstores. Here’s a time-capsule post with my predictions from the September 2006 $4 generic program launch: Wal-Mart's Generic Pricing Will Trigger Big Changes. (Yikes, I’ve been writing Drug Channels for a long time!)

• Retail competition for mail order began heating up, leading to The Great Mail Pharmacy Slowdown.

• Starting in 2006, Medicare Part D began shifting seniors from cash-pay to third-party-paid prescriptions. One of the pharmacy industry’s dirty little secrets is the fact that pharmacies can earn much higher profit margins from uninsured/underinsured individuals. (Yes, pharmacy owners really do complain when insurance coverage is expanded and drugs become more affordable.)

A prescient 2008 article by Norman Carroll predicted precisely the Part D profit decline. See Estimating the Impact of Medicare Part D on the Profitability of Independent Community Pharmacies (Journal of Managed Care Pharmacy, 2008). Dr. Carroll based his conclusions on the fact that pharmacy gross margins for cash-pay prescriptions averaged 43% in 2005, vs. third-party margins of about 20%. More recent data (from 2009) show cash-pay margins that were still 2X third-party margins. See The True Economics of Pharmacy Ownership.

Any other theories?